Servicing the Underbanked
By Jamie Fulmer
February 13, 2014
A new report from the United States Postal Service inspector general proposes that the agency offer non-bank financial services, including payday loans. Opinion pieces and blog posts praised this idea as a way for the post office to solve its fiscal woes while reaching a portion of Americans outside the traditional banking system. A Reuters “Great Debate” piece, “Transforming Post Offices into banks", called the proposal a “win-win.”
These pieces overlook some practical problems, however, and leave numerous questions unanswered about implementation. While government and charitable-sponsored financial services should play a role in consumer lending, they cannot replace market-based solutions.
Notably, the USPS proposal underestimates the challenge of offering consumer financial services in an increasingly competitive marketplace regulated by complex federal and state laws. Without a sizable government subsidy, the report’s suggested interest rate for small-dollar loans would not even cover basic operating expenses.
A number of credit unions, community banks and nonprofit organizations have started similar, artificially low-priced, small-dollar loan programs only to struggle to sustain operations, much less make a profit. This has led many institutions — credit unions in particular — to conclude they cannot viably provide short-term credit, according to research by University of California, Davis Professor Victor Stango.
Local storefront lenders can offer market-competitive prices — with rapidly diversifying portfolios, insights from data on consumer trends and operational efficiencies — to meet the growing demand for short-term loans and other non-bank financial services.
There is room for increased competition in this short-term credit marketplace. Consumers are always best served by a well-regulated, competitive environment with diverse options.
But comparable products must be governed by the same rules. The post office proposal does not explain how its products would be regulated at the federal and state levels, both in the extension and repayment of the loans. It suggests, for example, that USPS could “collect debts from the tax refunds of debtors” — a prospect with troubling consequences for Americans already struggling to make ends meet.
Many regulators and commentators misunderstand why nearly 68 million Americans — more than one-quarter of U.S. households — now choose alternative lenders over banks and credit unions. Underbanked Americans by definition have a bank account and access to mainstream financial services offered by traditional banks, so why are millions opting for alternative lenders?
First, their bank accounts often get nickel and dimed by hidden fees. Roughly 41 percent of financial institutions, according to a recent Wall Street Journal article, do not offer unconditional free checking accounts — up eight percentage points from last year. Monthly service fees have increased steadily since 2009 to a current high of $5.54.
These fees are often shrouded in opaque and confusing language. Customers value the transparency of alternative lenders, especially the clear disclosure of the fees associated with their loans.
Second, traditional lenders often force the underbanked or unbanked into expensive overdraft programs when they seek small-dollar credit. Moebs Services recently found that the median price per $100 borrowed through overdraft programs is $35 at large banks and $30 at smaller financial institutions. At storefront payday lenders, that same $100 costs $18.
Perhaps most important, the unbanked are put off by poor or even non-existent customer service at traditional banks. More than 75 percent said payday lenders were respectful and honest, according to a recent survey of borrowers by Harris Interactive and the Consumer Financial Services Association of America.
Lisa Servon, a professor at the Milano School of International Affairs, Management and Urban Policy at the New School who spent time working at an alternative lender, found that customers overwhelmingly value their local lender’s superior customer service and familiar faces.
Those who think that customers will be greeted with the same level of customer service at the U.S. Postal Service, without a considerable investment in training programs, should spend more time trying to mail a package from their local branch.